Imf report: Italy's financial stability

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Published on November 20, 2013

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Il rapporto del Fondo Monetario Internazionale sull'Italia. Nonostante le previsioni di una modesta crescita nel 2014, l'Italia secondo questo rapporto resta vulnerabile alle tensioni dell'eurozona e ai ritardi nelle politiche da adottare.

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IMF Country Report No. 13/299 ITALY September 2013 2013 ARTICLE IV CONSULTATION Selected Issues This paper on Italy was prepared by a staff team of the International Monetary Fund as background documentation for the periodic consultation with the member country. It is based on the information available at the time it was completed on September 6, 2013. The views expressed in this document are those of the staff team and do not necessarily reflect the views of the government of Italy or the Executive Board of the IMF. The policy of publication of staff reports and other documents by the IMF allows for the deletion of market-sensitive information. The policy of publication of staff reports and other documents allows for the deletion of market-sensitive information. Copies of this report are available to the public from International Monetary Fund  Publication Services 700 19th Street, N.W.  Washington, D.C. 20431 Telephone: (202) 623-7430  Telefax: (202) 623-7201 E-mail: Internet: Price: $18.00 a copy International Monetary Fund Washington, D.C. ©2013 International Monetary Fund

ITALY September 6, 2013 SELECTED ISSUES Approved By European Department Prepared By K. Kang, J. Tyson, B. Barkbu, S. Lanau (all EUR), A. Tiffin (SPR), L. Eyraud (FAD), G. Esposito and S. Pompe (LEG), N. Jassaud (MCM). Executive Summary Italian Productivity, Innovation, and Competitiveness In Italy, as in many countries, price-based competitiveness measures have not always been an accurate guide to subsequent trade developments. This chapter offers a more comprehensive assessment of Italian export competitiveness, focusing in particular on the Judicial System Reform A Key to Growth The inefficient Italian judicial system has contributed to a difficult business environment and lower investment. Improving the efficiency of the judicial system will require strengthening the mediation system, enhancing court management and accountability, and reforming the appeal system. Reforming Capital Taxation in Italy This chapter reviews capital taxation issues based on a comprehensive definition encompassing taxes on income, transactions, and ownership. It discusses options to enhance the neutrality of the capital income tax system, followed by a detailed analysis of the property tax, the inheritance tax, and various transaction taxes. The chapter also examines whether substituting a single net wealth tax for the set of existing taxes could be beneficial in the medium-term. Reforming Tax Expenditures in Italy The IMF has advised country authorities to roll back tax expenditures to support fiscal consolidation efforts. This chapter analyzes tax expenditures in Italy, considering the extent to which they can be considered part of an optimal tax system and, possible reforms. Strategy for Fostering a Market for Distressed Debt in Italy This chapter examines the framework for resolving NPLs and ways to accelerate writeoffs, through tax policies, legal reforms, and regulatory policies, using lessons from other countries. It focuses on developing a private market for restructuring distressed assets sheets and expand lending. Reforming the Corporate Governance Framework of Italian Banks Corporate governance is key for a well functioning banking system. The paper discusses the corporate governance of Italian banks, its regulatory framework, and specific challenges arising from dependence on foundations and cooperatives. It concludes with recommendations, in line with the FSAP, for strengthening corporate governance.

ITALY CONTENTS ITALIAN PRODUCTIVITY, INNOVATION, AND COMPETITIVENESS ____________________ 5 A. The Italian Competitiveness Puzzle _____________________________________________________ 5 B. Price Competitiveness___________________________________________________________________ 9 C. Non-Price Competitiveness ____________________________________________________________ 11 D. Market-Share Dynamics _______________________________________________________________ 12 E. Conclusion _____________________________________________________________________________ 15 References _______________________________________________________________________________22 FIGURE 1. Export Shares, by Industry Group, 2011 ________________________________________________ 8 TABLE 1. Changes in World Market Share and Shift-Share Decomposition: Large Exporters, 1995 2011 _____________________________________________________________________________ 16 JUDICIAL SYSTEM REFORM A KEY TO GROWTH _____________________________________24 A. The Italian Justice System A Contributor to a Difficult Business Environment ________ 24 B. Diagnostic and Possible Remedies _____________________________________________________ 27 References _______________________________________________________________________________35 REFORMING CAPITAL TAXATION IN ITALY ____________________________________________38 A. General Considerations ________________________________________________________________ 38 B. Enhancing the Neutrality of the Capital Income Tax System ___________________________ 41 C. Implementing a Fairer and More Effective Property Tax________________________________ 44 D. Reducing Distortionary Taxes on Transactions _________________________________________ 46 E. Strengthening the Taxation of Inheritance and Gifts ___________________________________ 49 F. Towards a More Comprehensive Taxation of Wealth? __________________________________ 52 G. Conclusions ____________________________________________________________________________ 56 References _______________________________________________________________________________58 2 INTERNATIONAL MONETARY FUND

ITALY BOX 1. Taxes on Asset Holding in Italy _________________________________________________________ 54 FIGURES 1. Capital Taxation in European Countries ________________________________________________ 39 2. Taxes on Weatlh Stock and Transactions in the OECD, 2011 ___________________________ 40 3. Revenues from Transaction Taxes, 2012 ________________________________________________ 47 4. Residential Mobility in OECD Countries ________________________________________________ 49 5. Effective Inheritance Tax Rates in Europe_______________________________________________ 50 6. Impact of a 1 Percent Wealth Tax on the Taxation of Real Returns of Investors ________ 56 TABLES 1. Capital Tax Measures in the 2011 Fiscal Packages _____________________________________ 40 2. Revenues from Taxes on the Wealth Stock in 2012____________________________________ 53 3. Composition of Italian Household Wealth per Net Wealth Decile _____________________ 54 REFORMING TAX EXPENDITURES IN ITALY ____________________________________________60 A. What Are Tax Expenditures? ___________________________________________________________ 60 B. Why Should Tax Expenditures Be Reformed? __________________________________________ 61 C. Are All Tax Expenditures Bad? __________________________________________________________ 61 D. How Can Tax Expenditures Be Identified and Quantified? _____________________________ 62 E. Once Identified, How Should Tax Expenditures Be Evaluated?__________________________ 63 F. What Types of Tax Expenditures Are There in Italy? ____________________________________ 63 G. Which Tax Expenditures Should Be Reformed and How? ______________________________ 68 References _______________________________________________________________________________70 BOX 1. Decomposing the IVA Policy Gap ______________________________________________________ 66 TABLES 1. Comparison of Tax Expenditures and Direct Spending _________________________________ 62 2. Summary of Largetst PIT Tax Expenditures _____________________________________________ 64 3. Summary of Largest Tax Expenditures__________________________________________________ 65 4. Summary of Largest VAT Tax Expenditures _____________________________________________ 67 5. Summary of Largest Excise Tax Expenditures ___________________________________________ 68 6. Illustrative Table of Tax Expenditures for Priority Review _______________________________ 69 INTERNATIONAL MONETARY FUND 3

ITALY STRATEGY FOR FOSTERING A MARKET FOR DISTRESSED DEBT IN ITALY____________71 A. Current Situation with NPLs in Italy ____________________________________________________ 71 B. Reasons behind the Slow Pace of Write-Offs ___________________________________________ 73 C. A Strategy for Developing a Distressed Debt Market __________________________________ 75 D. Conclusion _____________________________________________________________________________ 77 BOXES 1. International Practices for Write-Offs of NPLs __________________________________________ 74 2. Korea's Experience with Corporate Restructuring ______________________________________ 78 REFORMING THE CORPORATE GOVERNANCE OF ITALIAN BANKS___________________79 A. Concentrated Ownership and Foundation Influenced Banks ___________________________ 79 B. Cooperative Banks _____________________________________________________________________ 84 C. Governance Regulatory Framework ____________________________________________________ 86 D. Enhancing the Governance Framework in Italian Banks ________________________________ 88 E. Conclusion _____________________________________________________________________________ 89 References _______________________________________________________________________________90 4 INTERNATIONAL MONETARY FUND

ITALY ITALIAN PRODUCTIVITY, INNOVATION, AND COMPETITIVENESS1 In Italy, as in many countries, price-based competitiveness measures have not always been an accurate guide to subsequent trade developments. This chapter offers a more comprehensive assessment of Italian competitiveness, focusing in particular on the concern; although perhaps not as critical as some assessments have claimed. Italy still maintains a high-quality export mix, and the adaptability of small-scale specialized firms is still a source of strength. But small firm size is now less of an asset, and even the most innovative sectors are being weighed down by the structural barriers that have depressed Italian productivi - and institutional-reform agenda. A. The Italian Competitiveness Puzzle A loss in competitiveness without a collapse in exports 1. Over the past two decades, discussion of the Italian economy has increasingly centered on the key themes of weak growth and competitiveness. In this regard, a sustained drop in total factor productivity (TFP) growth, and the resulting increase in unit Top 10 Manufacturers labo by Value Added 2000 2010 2. Against this backdrop, however, Italian exports have held up relatively well. In an era dominated by the dramatic expansion of emergingin contrast to many other European parallel with its European peers (at least in value terms). Most recently, the buoyancy of exports in the face of depressed global demand underscores the continued adaptability and resilience of p-ranked exporter in textiles, clothing and leather goods; and is ranked second in the world (behind Germany) for non-electronic machinery and manufactures (basic and miscellaneous). Source: UN Statistics 1 Prepared by Andrew Tiffin (SPR). INTERNATIONAL MONETARY FUND 5

ITALY Productivity, Innovation, and Exports Part of the key to this puzzle may 3. the explanation most likely involves the changing nature of production, and the increased importance of innovation in maintaining sustained output growth (Aghion, 2011). As illustrated in the figure below, the Italian productivity experience is perhaps an amplified version of the (average) European experience; in which a process of trend convergence with the world leader ended in the mid 1990s, coinciding roughly with the information and communications technology (ICT) revolution (Bank of Italy, 2009). This latter development has often been described as a game-changing event analogous to the introduction of steam or electricity that has dramatically changed the nature of global production, and the requirements for firms and countries wishing to maintain their position at the global frontier (Crafts, 2012). In this regard, the ICT revolution has potentially expanded the scope for firms to distinguish between i) technological competitiveness, which is associated with the development of new products and requires substantial internal innovation (research, development, and design); and ii) cost competitiveness, which is associated instead with improved efficiency and lower labor costs (see Bogliacino & Pianta, 2010). For Italian firms facing increased cost-based competition from emerging-market exporters, the former is perhaps becoming more and more important. 4. This chapter will explore the extent to which the performance of Italian exporters reflects their relative ability to innovate and adapt to a changing global environment. Although the economy as a whole may have faced difficulty integrating and exploiting new technologies to boost performance reflecting perhaps a broad range of structural and administrative impediments it may be that Italian exporters have had better success. To this end, es of innovation: extending the Pavitt (1984) Industrial Taxonomy, and separating each export industry into one of five separate GDP per Hour (in 2012 USD) 60 ICT Revolution Productivity Gap Narowing 50 40 Productivity Gap Widening 30 20 1970 1975 1980 1985 1990 Source: The Conference Board, Total Economy Database 6 INTERNATIONAL MONETARY FUND 1995 2000 2005 2010

ITALY groups2: Science-based industries, such as pharmaceuticals, high-end electronics, and aviation, are dominated by large firms, where innovation is typically internal to the firm and based on advances in science. Specialized supplier industries, which are often dominated by smaller firms that design, develop and produce equipment tailored specifically to a particular production process or need. Traditional industries, such as textiles, furniture, food, and basic manufactures, where internal innovation is less relevant, and new technology comes from external suppliers of equipment and material. Scale-intensive industries, where innovations are mainly derived from the exploitation of economies of scale. These can be further broken down into: Technology-based scale-intensive industries, such as motor vehicles and other transport equipment. Resource-based scale-intensive industries, such as industrial chemicals, refined petroleum products, basic metals, and processed foodstuffs. 5. ubstantial weight of traditional products, but also has a large proportion stemming from specialized-suppliers. Indeed, although a key development over the past 15 years has been the shrinking importance of the traditional sector, and the growing importance of scale-intensive resource-ba is the large and stable share originating from specialized suppliers. In comparison to other countries, the share owing to these suppliers is more akin to that seen in Germany or the United States (Figure 1). 6. I Firms in this sector tend to be small and medium in size, with a marked capacity for incremental innovation and a diversified range of high-quality, high-margin products with few substitutes (such as machine tools, precision instruments, and specialized machinery for industry and agriculture). Often organized within a flexible network of small firms or industrial districts, it is the inventiveness and agility of this sector that has been highlighted in the past as one of the main factors allowing Italy to maintain its relative world position.3 This chapter will explore the extent to Export Shares, by Industry Group 100% 80% 60% 40% 20% 0% 1995 Science-Based Traditional Scale-Based (Resource) 2007 2011 Specialized-Supplier Scale-Based (Tech) Source: COMTRADE, IMF staff calculations 2 See Kubielas (2007) for a Pavitt-based classification of each industry by ISIC rev.3 3 See Porter (1990) and Ginsborg (2003). INTERNATIONAL MONETARY FUND 7

ITALY which this sector has continued to remain competitive despite apparently adverse developments -based competitiveness indicators. Figure 1. Export Shares, by Industry Group, 2011 (Deviation from EU average, percentage points) 8 INTERNATIONAL MONETARY FUND

ITALY PPI-Based Harmonized Competitiveness Indicators, 1999-2012 (Index, end 1998=100) ULC-Based 120 120 110 110 100 100 90 90 80 80 70 70 Source: Bank of Italy, ECB, IMF staff calculations B. Price Competitiveness Unit Labor Costs vs. Price-Based Measures 7. standard price-competitiveness indicators present a mixed picture. Although the dispersion of different competitiveness indexes is a feature in many European countries, it is particularly evident in Italy, where ULC-based indicators routinely suggest a substantially larger loss in competitiveness compared to other CPI- or PPI-based indicators (Bayoumi and others, 2011). Using a total-economy ULCup to 5 percent since adoption of the euro, compared to an improvement in Germany of nearly 20 percent. Using a PPI-based measure, on the other hand, the gap between the two countries is considerably narrower, and Italy is not materially less competitive than it was in 1999. 8. Labor-cost measures may present an incomplete picture, and should perhaps be complemented. Part of the discrepancy between the different types of measures may again reflect the changing nature of global production. In an era of globalization and international supply chains, the share of domestically employed labor in total production costs is decreasing, albeit to a different degree in different countries indeed, wage shares in the manufacturing sector fell sharply in Germany between 1998 and 2007, but only marginally in Italy over the same period (Giordano & Zollino, 2013). Labor-cost-based indicators, therefore, may reflect a subset of costs that are perhaps competitiveness. Arguably, then, price-based indicators may provide a better guide. INTERNATIONAL MONETARY FUND 9

ITALY Supply-Chain Based Indicators 9. IMF staff have developed alternative measures that address the implications of global supply chains on the assessment of price competitiveness. Conventional measures are typically not well suited to instances when imports are used to produce exports, as they tend to assume that only domestic inputs -added Real Effective Exchange Rate (VA- compete in the supply of value2012). In this framework, to take the typical example, China is not competing with other countries in the supply of iPhones, but rather in the supply of final-assembly services, which form only a small portion of the -chain position, and improving on the (laborfocused) ULC indicator in the previous section,the VA-REER thus captures the overall cost the same issue by instead modifying the standard price-based REER approach, to include an additional term that reflects the role of outsourcing in offsetting the impact of domestic factor-price inflation (Bayoumi, Saito, & Turunen, 2013).This measure is therefore more focused on the actual price 10. For Italy, the differences between these alternative measures are illustrative. Considering the cumulative Italian appreciation since adoption of the euro, the tasks-based VA-REER gives roughly the same assessment as the standard CPI-based REER. The modified price-based measure, on the other hand, suggests a substantially less-marked decline in competitiveness. This suggests that rising factor costs in Italy have not translated into an equivalent increase in the relative price of Italian goods, owing in part to role of lowSupply-Chain Based Real Effective Exchange Rates (Cumulative Appreciation, percent, 1999-2012) cost imports from low inflation countries. Interestingly, Germany presents the opposite picture. 5 The sharp increase in competitiveness implied by falling factor costs in Germany has not been fully 0 matched by lower export prices, owing to the fact that Germany imports a large and increasing -5 proportion of its inputs from countries with relatively -10 high inflation. Looking at a wide range of indicators, therefore, the competitiveness challenge in Italy may -15 not be as immediately dire as suggested by a focus Tasks Goods solely on cost-based measures. Source: Bayoumi, Saito & Turunen (2013) 10 INTERNATIONAL MONETARY FUND

ITALY C. Non-Price Competitiveness Quality Indicators 11. The relative strength of Italian exporters may also reflect their ongoing efforts to fend off competition by upgrading the quality of their products. Past IMF staff research has emphasized the important role of non-price Export Unit Value rt performance (percent change, y/y) (Lissovolik, 2008), and quality upgrades have 10 featured prominently in this regard (Codogno, 2009). Export quality cannot be observed directly, 5 but the clearest evidence of this trend is in the 0 persistent upward movement of export unit values, which are generally taken as a key proxy -5 for quality. Indeed, averaging across all export sectors, unit values in Italy are around 1½ times -10 higher than the global mean.4 1998 2000 2002 2004 2006 2008 2010 2012 12. Source: ISTAT, IMF staff calculations Recent IMF staff research confirms Percent of Exports 40 30 20 10 Quality Ladder Other Misc. Manufactures Machin. & Transport Manuf. Goods Chemicals 0 Export Share (RHS) Animal & Veg. Oils Minerals Crude Materials Food Bev. & Tobacco high quality of its export mix. Although unit values are useful, they are a somewhat noisy indicator of quality, as they also reflect a range of other factors, including cost differences. Henn, Papageorgiou, & Spatafora (2013) calculate a more consistent, less noisy, set of quality indicators; based on unit values, but estimated within a sector-specific gravity-equation framework. The results suggest that Italy remains at the top of the global quality ladder across all its major exports, even those associated with more traditional industries. Quality Index (1 = 90th percentile) .2 .4 .6 .8 0 1 1.2 Italy: Export Quality by Sector, 2009 Italy Position Source: Henn, Papageorgiou & Spatafora (2013) 4 WTO/UNCTAD relative unit-value data is available at INTERNATIONAL MONETARY FUND 11

ITALY D. Market-Share Dynamics Shift-Share Analysis 13. In light of the mixed picture presented above, perhaps a more telling indicator of Italian competitiveness is the actual evolution of Share of World Exports (percent) its global market share. But a simple investigation Italy Germany France UK of markets shares raises the following issue: two Japan China countries with similarly competitive exporting firms 10 may nonetheless display different performances over the short- to medium-term, if one has a more favorable mix of products (at the time), or if it 5 exports to a particularly dynamic set of destinations. 10 underlying competitiveness, therefore, will strip out such product and geographical effects. 0 5 0 1990 1995 2000 2005 2010 14. The following analysis employs a shiftSource: DOTS, IMF staff calculations share approach measure of market-share growth. Also known as constant market-share analysis (CMSA), shiftshare analysis (SSA) is an econometric approach that allows the decomposition of changes in a s market share should also remain constant but if it decreases even after for controlling for its exporters are underperforming. In the following analysis, market shares are measured in value terms, and so incorporate the quality improvements outlined above. 15. The approach is based on a fixed-effects regression of detailed bilateral trade flows. Drawing on the methodology outlined by Cheptea (2005) and revised by Bricongne and others (2013), the methodology starts with the following equation: Where it jt, and kt are exporter, importer, and product fixed effects that can vary across time. The dependent variable is disaggregated export growth; based on a mid-point measure so as to take into account the possibility of entry and exit from a particular export line (i.e. the extensive margin of trade). For any country, estimation of these fixed effects allows the decomposition of market-share growth into three separate components: A sectoral component measuring growth due to the mix of products exported A geographical component capturing changes due to the distribution of trading partners. underlying price and non-price competitiveness. 12 INTERNATIONAL MONETARY FUND

ITALY The estimation draws from the bilateral dataset developed by Gaulier & Zingano (2010), which provides reconciled values of all international trade flows for about 5000 product headings from the 6-digit Harmonized System (HS) classification over the years 1995-2011 (See Appendix I for a more detailed treatment of the methodology and dataset). Results 16. Looking at exports ket share has historically been weighed down by an unfortunate export mix. Like most other advancedexports has fallen with the introduction of emerging-market exporters into the global trading system. A detailed decomposition of growth rates for a number of countries is presented in Table 1, but for the pre-crisis period (1995-2007), the figure below suggests that Italy has generally managed to orient its exports to markets with a rapidly expanding demand for imports, while its product mix has been biased towards products where growth has been less dynamic. 5 Taking these two effects critical as it might appear at first. Indeed, its underlying competitiveness compares favorably to countries such as France or the United Kingdom, and is broadly comparable to that of Germany. Looking at export-share developments over the post crisis period (2007-2011), most European countries suffered from a sudden downturn in demand from their main export partners. And again, Italy seems to have been additionally held back by a poor product mix, but the adjusted measure is nonetheless broadly in line with that of France or the United States, where price-competitiveness measures have typically been more favorable than those in Italy. Decomposition of Market Share Growth, All Exports (percent annualized) 2007-2011 1995-2007 3 3 Product Mix Geography Adj. Mkt Share Mktshare 0 0 -3 -3 -6 -6 JPN UK USA FRA ITA GER PRT ESP UK USA JPN ITA FRA ESP GER PRT 5 The sample length is chosen to take advantage of the full dataset, but it should be noted that his period includes the years previous the introduction of the euro, when Italian exports were still benefiting from the lira devaluation of the early-1990s. The devaluation may have created some room for the loss of competitiveness recorded in the subsequent years. INTERNATIONAL MONETARY FUND 13

ITALY 17. Focusing on science-based industries, Italian exporters have generally been much more successful in targeting products with better prospects for growth. Indeed, Italy has mostly managed to maintain or even increase its market share in this sector. But this represents only a small fraction of Italian exports, and the adjusted market-share measure paints an even less rosy picture; suggesting that exporters in this sector are still being held back by an underlying lack of competitiveness. Decomposition of Market Share Growth, Science-Based Exporters (percent annualized) 1995-2007 2007-2011 5 5 0 0 -5 -5 -10 Product Mix Adj. Mkt Share Geography Mktshare -15 -10 -15 JPN ITA UK USA FRA GER ESP PRT USA UK PRT JPN ITA GER ESP FRA 18. Turning to specialized suppliers, Italy again seems to have had some success in focusing on high-growth products, but the underlying competitiveness measure is nonetheless worrisome. In context, the competitiveness of the sector is perhaps not an issue of critical concern as it still fares favorably compared to countries like France and the United Kingdom, and historically is not too far removed from Germany. But looking forward, the fact that supplier exports may not be the source of strength that they once were. Partly, this may be the cumulative result of the distortions, rigidities, and administrative impediments that have helped stifle growth in the broader Italian economy; and which are now weighing even on this oncedynamic sector. Alternatively, it may also reflect the changing nature of global production; where larger scale firms tend to be more successful in generating worldwide brand recognition, securing access to finance, and integrating into global supply chains. And where small firm size which once helped ensure the agility and resilience of the Italian export sector is now less of an asset. Indeed, from a policy viewpoint, if firm size and global reach are now more important, there is perhaps a growing need for structural reforms that can remove the barriers to firm growth and encourage inward FDI. These reforms would also help the science-based sector described above, which appears 14 INTERNATIONAL MONETARY FUND

ITALY Decomposition of Market Share Growth, Specialized Product Exporters (percent annualized) 2007-2011 1995-2007 0 0 -4 -4 Product Mix Adj. Mkt Share -8 UK JPN USA FRA Geography Mktshare ITA GER ESP -8 PRT FRA ITA USA ESP UK PRT JPN GER E. Conclusion 19. In Italy, as in many countries, price-based competitiveness measures have not always served as an accurate guide to subsequent trade developments. These measures, such as relative unit labor costs, are simple to communicate and are often linked closely to the instruments available to policy makers. But globalization is reshaping the relationship between trade performance and price factors, with the latter providing less and less explanatory power for export growth (Di Mauro and others, 2008). 20. This chapter has In light of the dispersion -based indicators, it is perhaps more instructive to look at the -price factors such as quality, innovation, and flexibility ccess in the past. The overall appraisal is that Italian competitiveness is indeed a matter of concern; although perhaps not as critical as some assessments have claimed. Italy still maintains a high-quality export mix, and the adaptability of Italian firms is still a source of strength. But even the most innovative and flexible sectors are being weighed down by the structural impediments that have depressed Italian institutional and macroeconomic conditions that allow productive firms to innovate, expand, and attract inward FDI; - and institutional-reform agenda. INTERNATIONAL MONETARY FUND 15

ITALY Table 1. Changes in World Market Share and Shift-Share Decomposition: Large Exporters, 1995.2011 (Annualized growth, percentage points) Market Adjusted Structural Effects Share Mkt Share Geography Product Mix All Export Industries China 1995-2007 2007-2011 1995-2007 2007-2011 1995-2007 2007-2011 8.6 5.1 -2.1 -3.4 -0.1 -2.0 12.8 6.6 -3.1 -2.4 -1.3 -0.5 -1.8 0.0 0.4 -1.5 0.6 -1.3 -2.0 -1.4 0.6 0.4 0.5 -0.3 Italy 1995-2007 2007-2011 -1.5 -4.1 -1.4 -2.6 0.4 -1.2 -0.6 -0.3 Japan 1995-2007 2007-2011 1995-2007 2007-2011 1995-2007 2007-2011 1995-2007 2007-2011 1995-2007 2007-2011 -3.8 -1.5 -1.4 -0.7 0.6 -2.3 -2.9 -5.0 -2.6 -1.7 -4.3 -2.6 -0.3 3.3 0.6 -0.6 -3.7 -4.0 -3.5 -3.1 -0.2 2.1 0.3 -3.3 -0.1 -1.5 0.1 -1.7 0.3 1.1 0.7 -0.9 -1.4 -0.6 0.1 -0.2 0.8 0.7 0.6 0.4 1995-2007 2007-2011 1995-2007 2007-2011 1995-2007 2007-2011 15.7 6.3 -0.4 2.6 2.1 0.4 21.1 11.5 -3.1 0.4 0.0 -1.3 -1.1 0.3 0.3 -0.1 0.1 -1.1 -3.4 -5.0 2.4 2.3 2.0 2.8 Italy 1995-2007 2007-2011 -1.2 1.6 -4.7 -1.7 0.2 -0.9 3.4 4.3 Japan 1995-2007 2007-2011 1995-2007 2007-2011 1995-2007 2007-2011 1995-2007 2007-2011 1995-2007 2007-2011 -12.1 -6.3 5.6 -5.5 3.4 3.3 -2.6 -4.7 -2.4 -5.0 -9.5 -4.6 5.0 -4.9 0.5 -0.9 -3.6 -6.0 -3.1 -6.0 0.3 -0.1 0.0 -2.3 -0.4 0.0 -0.2 -0.3 0.2 0.7 -3.1 -1.6 0.6 1.7 3.3 4.3 1.2 1.6 0.5 0.3 France Germany Portugal Spain United Kingdom USA Science-Based Industries China France Germany Portugal Spain United Kingdom USA Source: IMF Staff calculations using BACI database, developed by Gaulier & Zingano (2010) 16 INTERNATIONAL MONETARY FUND

ITALY Table 1 (cont.). Changes in World Market Share and Shift-Share Decomposition: Large Exporters, 1995.2011 (Annualized growth, percentage points) Market Adjusted Structural Effects Share Mkt Share Geography Product Mix Specialized Supplier Industries China 1995-2007 2007-2011 1995-2007 2007-2011 1995-2007 2007-2011 13.0 6.5 -2.5 -5.2 -1.1 -2.5 15.2 7.3 -3.4 -4.3 -2.2 -1.8 -1.4 -0.2 0.5 -1.5 0.7 -1.2 -0.5 -0.6 0.5 0.6 0.5 0.5 Italy 1995-2007 2007-2011 -1.5 -4.9 -2.7 -4.1 0.7 -1.3 0.5 0.5 Japan 1995-2007 2007-2011 1995-2007 2007-2011 1995-2007 2007-2011 1995-2007 2007-2011 1995-2007 2007-2011 -4.7 -0.9 1.0 -6.3 -0.2 -4.8 -4.3 -4.4 -3.4 -2.1 -4.7 -2.5 1.1 -3.2 -0.5 -3.3 -4.7 -3.2 -4.0 -3.4 -0.3 1.5 0.1 -3.1 0.1 -1.9 0.1 -1.7 0.2 0.8 0.2 0.2 -0.2 -0.2 0.2 0.3 0.3 0.5 0.5 0.5 1995-2007 2007-2011 1995-2007 2007-2011 1995-2007 2007-2011 5.4 3.4 -1.9 -3.5 0.1 -3.1 8.6 4.3 -2.6 -3.0 -2.0 -2.2 -1.9 -0.4 0.6 -0.7 1.4 -0.2 -1.0 -0.4 0.1 0.2 0.8 -0.7 Italy 1995-2007 2007-2011 -2.2 -5.1 -2.5 -4.4 0.5 -0.6 -0.3 -0.2 Japan 1995-2007 2007-2011 1995-2007 2007-2011 1995-2007 2007-2011 1995-2007 2007-2011 1995-2007 2007-2011 -4.2 0.4 -3.7 -1.5 0.7 -1.7 -2.9 -5.3 -2.9 -0.5 -4.7 -2.9 -4.0 1.6 0.4 -0.7 -4.5 -4.7 -5.6 -2.1 0.3 3.5 0.8 -2.2 0.6 -0.5 1.1 -1.4 1.8 0.9 0.1 -0.1 -0.4 -0.9 -0.3 -0.6 0.5 0.7 1.1 0.7 France Germany Portugal Spain United Kingdom USA Traditional Industries China France Germany Portugal Spain United Kingdom USA Source: IMF Staff calculations using BACI database, developed by Gaulier & Zingano (2010) INTERNATIONAL MONETARY FUND 17

ITALY Table 1 (cont.). Changes in World Market Share and Shift-Share Decomposition: Large Exporters, 1995.2011 (Annualized growth, percentage points) Market Adjusted Structural Effects Share Mkt Share Geography Product Mix Scale-Intensive Technology-Based Industries China 1995-2007 2007-2011 1995-2007 2007-2011 1995-2007 2007-2011 14.6 14.3 -2.3 -6.7 0.8 -0.5 17.4 11.4 -2.6 -3.8 0.4 1.1 -2.4 1.4 0.3 -2.7 0.4 -1.2 0.0 1.3 0.0 -0.2 0.0 -0.4 Italy 1995-2007 2007-2011 -0.7 -5.7 -0.1 -4.3 -0.5 -1.4 0.0 0.0 Japan 1995-2007 2007-2011 1995-2007 2007-2011 1995-2007 2007-2011 1995-2007 2007-2011 1995-2007 2007-2011 -3.1 -2.3 -0.2 3.9 -0.3 -4.0 -0.7 -2.7 -2.0 -0.3 -2.3 -4.4 0.3 8.9 0.5 -2.1 -0.3 -1.2 -3.0 -1.0 -0.8 2.3 -0.7 -4.1 -0.9 -1.7 -0.4 -1.2 1.1 1.0 0.1 -0.1 0.1 -0.4 0.0 -0.4 0.0 -0.3 -0.1 -0.2 France Germany Portugal Spain United Kingdom USA Scale-Intensive Resource-Based Industries China 1995-2007 2007-2011 1995-2007 2007-2011 1995-2007 2007-2011 8.2 3.1 -2.7 -4.0 -0.9 -2.4 11.0 4.3 -3.1 -2.1 -1.4 -0.3 -2.2 0.6 0.2 -1.8 0.5 -1.6 -0.3 -1.7 0.2 -0.1 -0.1 -0.5 Italy 1995-2007 2007-2011 -0.8 -3.3 -1.0 -0.9 0.2 -1.7 0.0 -0.6 Japan 1995-2007 2007-2011 1995-2007 2007-2011 1995-2007 2007-2011 1995-2007 2007-2011 1995-2007 2007-2011 -1.8 0.4 0.6 0.9 1.0 -1.3 -3.1 -6.1 -2.5 -0.2 -1.4 -1.2 1.0 3.9 1.5 1.1 -3.6 -4.7 -2.4 -1.9 -0.7 2.9 0.7 -2.6 -0.1 -1.9 0.1 -1.8 0.0 1.1 0.3 -1.2 -1.1 -0.3 -0.4 -0.6 0.4 0.3 -0.1 0.6 France Germany Portugal Spain United Kingdom USA Source: IMF Staff calculations using BACI database, developed by Gaulier & Zingano (2010) 18 INTERNATIONAL MONETARY FUND

ITALY Annex 1. Shift-Share Analysis and Competitiveness (from ECB, 2012) The method envisages a decomposition of export growth based on a weighted variance analysis (ANOVA) of bilateral export data, disaggregated by product. The methodology is based on Cheptea and others (2005), and seeks to identify the export growth of each exporting country as if all exporters had the same geographical and sectoral specialization. This is important for export data, as export growth rates are affected by structural effects: exporters with strong positions in the most dynamic destination markets or specialized in high-growth sectors benefit, ceteris paribus, from stronger grch 1owth. performance can be assessed separately from geographical and sectoral effects. The computation of the method consists of four main steps: Step 1: Compute mid-point growth rates For a country i exporting a value x to a country c of product k at time t, the mid-point growth rate is defined as follows: Similarly, the weight attributed to each flow gickt is given by the relative share of the flow in total exports, where total refers to the exports of the whole sample of countries: The year-on-year growth rate of the total value of world exports is given by summing each individual flow gickt weighted by sickt. Step 2: Fixed-effect regression Starting from a dataset disaggregated by destination and sector (or product), the ANOVA methodology is used to decompose export growth into a sectoral effect, a geographical effect and a pure export competitiveness effect. Specifically, the mid-point growth rate is regressed on three sets of fixed effects, i.e. exporter, importer and sector/product fixed effects, here denoted with the letter f by means of a weighted OLS estimation. A separate regression is carried out for each year in the data. Hence, if is the intercept, is the regression coefficient for exporter fixed effects, the one for importer fixed effects, the one for product/sector fixed effects, and the error term, this can be written as: The terms fi , fc and fk are the exporter country, importer country and sector-specific fixed effects, respectively. In the regression, one exporter i, one importer c and one sector k is omitted to avoid perfect multicollinearity with the constant The constant term corresponds to the export growth of the reference country and the coefficients have to be interpreted as deviations from the INTERNATIONAL MONETARY FUND 19

ITALY performance of this country. In Step 3, however, the effects are normalized so as to quantify them as deviations from the average growth rate of exports for the overall sample in the dataset (in our case this roughly corresponds to world export growth). Step 3: Computation of the indices from the estimated coefficients From the estimated coefficients, growth is decomposed for each exporter (i.e. aggregating destination and product dimensions). First, however, the coefficients need to be normalized. Below, indicates the performance for exporter i relative to the omitted destination and sector. By contrast, is the marginal average for i the choice of omitted destination. It gives the export growth that country i would have if its geographical and sectoral specialization were equal to the average for the full sample. This is our measure of export performance (competitiveness). To obtain such a term, least-squares is needed which means computation. In other words, for each exporter i, a normalized coefficient is needed for the fixed effects, by summing them up to a constant term equal for all i the partner and product effects (weights are selected as above). This method generates identical results regardless of the choice of the omitted term in the estimation procedure, so that: This then . The first component is the adjusted export growth Where and rate, and the second and third components are the geographical and product-mix effects, respectively. The sum of annual growth rates provides the cumulative change over time so that: The change in export shares is then simply the country-specific growth rate, less the overall growth rate of world trade. Data The analysis draws from the BACI product-level database developed from COMTRADE data by Gaulier & Zingano (2010), which provides reconciled USD flow figures on more than 200 countries over roughly 5000 products of the Harmonized System (HS) classification. Following Cheptea and others (2012), flows below USD10,000 and those involving micro states are excluded, as are mineral, 20 INTERNATIONAL MONETARY FUND

ITALY specific and non-classified products. For the regressions, 6-digit product data are aggregated down to the 2-digit level. 6 6 This implies that, for 2-digit categories containing a large set of products, any product-mix effect that happens within the 2-digit category will be captured by the residual component (adjusted market share) and not by the product-mix component. For a more complete discussion of the caveats associated with this methodology, please see Cheptea and others (2012). INTERNATIONAL MONETARY FUND 21

ITALY References Aghion, P., and P.Howitt, 2009, The Economics of Growth, (MIT Press). ystem Occasional Paper No.45 (Bank of Italy: Rome). IMF Working Papers 11/140, (International Monetary Fund). Bayoumi, T., M.Saito and J.Turunen IMF Working Papers 13/100, (International Monetary Fund). (National Bureau of Economic Research, Inc). NBER Working Papers 18498, Research Policy, Elsevier, vol. 39(6), pages 799-809. Bricongne, J., L.Fontagné, G Journal of International Economics, Elsevier, vol. 87(1), pages 134-146. saggregated View by Shift- Working Papers 2005-23, CEPII research center. Working Papers 393, (Banque de France). ctivity Growth and Competitiveness Really so Working Paper 2009-2, (Department of the Treasury, Italian Ministry of the Economy and of Finance). The Golden Age and the Second Globalization of Italy Quaderni di storia economica (Economic History Working Papers) No.17, (Bank of Italy: Rome). Perspective CEPR Discussion Paper 8827, (C.E.P.R. Discussion Papers). Di Mauro, F., R.Rüffer, and I.Bunda, hanging Role of the Exchange Rate in a Globalised Economy Occasional Paper Series, No 94, (European Central Bank). m 139, (European Central Bank). 22 INTERNATIONAL MONETARY FUND Occasional Paper Series

ITALY Gaulier, G., and S 1994- BACI: International Trade Database at the Product-Level. The Working Papers 2010-23, (CEPII Research Center). Gaulier, G., D.Taglioni, and S.Zignago, 2013 mance in the Wake of the Global Crisis: mimeo. Ginsborg, P., 2003, Italy and Its Discontents: Family, Civil Society, State, (Palgrave Macmillan). Giordano, C. and F.Zollino, 2013, for Italy: An Assessment Bank of Italy, mimeo. Henn, C., C.Papageorgiou, and N.Spatafora, 2013, Export Quality in Developing Countrie Working Papers 13/108, (International Monetary Fund). IMF Growth in Polish Industry orkshop on Agglomeration and Growth in Knowledge-Based Societies, April 20-21, 2007, (IfW: Kiel). Lissovolik, B., 2008, Trends in Italy's Nonprice Competitiveness IMF Working Papers 08/124, (International Monetary Fund). Research Policy, Elsevier, vol. 13(6), pages 343-373. Porter, M., 1990, The Competitive Advantage of Nations, (Free Press: New York). INTERNATIONAL MONETARY FUND 23

ITALY JUDICIAL SYSTEM REFORM A KEY TO GROWTH1 The inefficiency of the Italian judicial system has contributed to reduced investments, slow growth and a difficult business environment. The enforcement of civil and commercial claims suffers from excessive delays in court proceedings, resulting in a very large number of pending cases. The Italian authorities have over the years taken steps to remove bottlenecks and speed up judicial proceedings. While these measures are generally steps in the right direction, shortcomings remain. To address these, consideration could be given to, inter alia, reviewing court fees, further improving the new mandatory mediation scheme, strengthening court management, and reforming the appeal system. A. The Italian Justice System Environment A Contributor to a Difficult Business 1. An efficient justice system is essential for sustained economic growth. A wellfunctioning, independent and efficient justice system is one where decisions are taken within a reasonable time, are predictable and effectively enforced, and where individual rights, including property rights, are properly protected.2 As further elaborated below, improving the efficiencyof the judicial system can help improve the business climate, foster innovation, attract FDI, secure tax revenues and support economic growth. This paper focuses on the enforcement of civil and commercial claims in Italy as a key way to improve the environment for sustaining economic growth. 2. The performance of the Italian justice system is well below European and OECD averages. Of note, it takes an average of 1,200 days to enforce a contract in Italy, more than twice the OECD highs European Commission for the Efficiency of Justice (CEPEJ), 2012). Similar statistics from the 2013 EU Justice Scoreboard show that relative to its European peers, Italy scores poorly on the time needed to resolve administrative, civil and commercial cases. The OECD average to complete a civil case up to the Supreme Court level is 788 days, while it is almost 8 years in Italy (OECD, 2013). As a result, 1 Prepared by Sergi Lanau (EUR), Gianluca Esposito (LEG), and Sebastian Pompe (LEG consultant). This paper has benefited from comments and inputs received from Kenneth Kang, Ross Leckow, Yan Liu, Justin Tyson, and David Velazquez-Romero. The authors would also like to thank the staffs of the Italian Ministry of Economy and Finance, the Ministry of Justice, and the Bank of Italy for helpful discussions and suggestions. 2 See, for instance, Article 6 and Article 1 of Protocol No. 1 of the European Convention on Human Rights. 24 INTERNATIONAL MONETARY FUND

ITALY 3500 1400 Days to Enforce a Contract 1200 Slowest Civil Procedures in Europe (Days) 3000 1000 3500 3000 2500 2500 800 Final Instance 2000 600 400 1st Instance 1500 200 2000 2nd Instance 1500 Italy Slovenia Ireland Solovakia Spain Portugal Belgium UK Denmark Austria Germany France Finland USA Norway Luxembourg 1000 0 1000 500 500 Spain Source: Doing Business, 2013 Scotland France Slovenia Italy Source: OECD (2013). 1400 1400 Article 6 Violations for Length of Court Proceedings (cases) 1200 0 0 1200 45 40 35 1000 30 800 800 600 600 400 400 200 (30) (14) (23) (17) 10 200 (17) 25 5 Source: ECtHR. Italy Turkey Greece Poland Ukraine France Slovenia 0 Hungary Bulgaria 0 Slovakia 1000 Enforcing a Contract 1/ (Number of steps) 20 15 0 AUT NLD GBR FRA DEU SWE PRT DNK ESP GRC ITA Source: Doing Business, 2012 1/ Cost of litigation, defined as the percent of dispute value shown in brackets where available. requirement enshrined in Article 6 of the European Convention on Human Rights (ECHR). The Fraser Institute ranks Italy 112th in terms of legal enforcement of contacts and the World Economic Forum (2013 Report) ranks it 139th in terms of the efficiency of the legal framework. While 2012 has witnessed a reduction in the number of pending cases in courts, these numbers remain high overall, with 9.7 million pending cases, including about 5 million pending civil cases (end 2012 figures).3 3. The economic literature has established a positive link between the efficiency of the judicial system and growth. Growth is projected to average 0.7 percent during 2013 18 and in the absence of deeper structural reforms potential growth is estimated at around ½ percent. A number 3 For data on the number of pending civil and criminal cases in Italy, see Ministry of Justice data and the Report of the Italian Senate, Dati statistici relative all-amministrazione della giustizia in Italia (May 2013). By the end of 2011, there were also about 870,000 pending tax(See the ). INTERNATIONAL MONETARY FUND 25

ITALY of factors unrelated to the judicial system are relevant to understand the dynamics of Italian growth (e.g., ageing population and public-administration inefficiencies), but a large body of literature suggests that weaknesses in the judicial system also adversely affect growth. The key channels linking the judicial system and growth are: Foreign direct investment. Inward FDI is positively correlated with the quality of legal institutions (Bénassy-Quéré et al., 2007). In turn, FDI has been linked to better growth outcomes (Lim, 2001). Inward FDI is indeed low in Italy and the judicial system may be one of the factors deterring foreigners from investing in the country. Annual FDI inflows over 2005-11 were about 1 /3 of the euro area average as a percent of GDP. Development of credit markets and cost of credit. Weak contract enforcement makes banks reluctant to lend, increases the cost of borrowing, and shortens maturities (Bae and Goyal, 2009; Laeven and Majnoni, 2003), with a detrimental impact on investment and GDP (Bianco et al., 2002; Laeven et al., 2003; Djankov et al., 2008). Firm size. There is a positive correlation between the quality of the judicial system and firm size (Kumar et al. 2001, Beck et al. 2006). Weak incentives to invest and hire workers under uncertain contract enforcement and costly dismissal procedures are two factors that could explain this correlation.4 Italy certainly fits the pattern: SMEs account for nearly 70 percent of value added and, as discussed above, the judicial system is inefficient along many dimensions. Giacomelli and Menon (2012) use differences in court efficiency across Italian municipalities to establish a causal link and estimate that halving the length of civil proceedings could increase average firm size by 8 12 percent. Weak enforcement reinforces vulnerabilities. Weak enforcement leads to late payments, which triggers liquidity issues, bumps up insolvency and increases unemployment. The so-called t system (Intrum Justitia, 2013). Entrepreneurship and innovation. Ardagna and Lusardi (2008) establish a link between entrepreneurship rates and the efficiency of the judicial system using micro data for a sample of countries including Italy. Berkowitz et al. (2006) find that stronger contract-enforcement institutions are positively correlated with more complex exports and less sophisticated imports. The structure of exports suggests that entrepreneurship and innovation may suffer from judicialsystem inefficiencies in Italy: high-technology products account for only 7 percent of manufactured exports, 9 percentage points below the OECD average. 4 In the case of Italy, long judicial proceedings for worker dismissals result into higher firing costs for firms with more than 15 employees. 26 INTERNATIONAL MONETARY FUND

ITALY B. Diagnostic and Possible Remedies 4. This section highlights the main reasons for the inefficiency of the Italian judicial system. It then describes the measures taken by the authorities to address some of the shortcomings, and concludes by making recommendations for further reforms that the authorities could consider. Main reasons for the inefficiency and bottlenecks 5. A combination of large number of courts and low court fees has been a source of inefficiency. Italy has the second highest number of courts in the EU (1,231 first instance courts of 5 general jurisdiction (CEPEJ, 2012) and it has traditionally had low court fees. Low court fees have a dual effect: they lead to larger inflow of cases and a higher appeal rate, and they increase public expenditure, since only a very small part of costs are passed on to the market. The issue of court fees is now being re-considered in Italy. 6. Another source of inefficiency is the large number of pending cases in courts. This is mainly due to the high inflow of cases, low clearance rates, and extended disposition time6 (Checchi, 1975; Chiarloni, 1999). The inflow is very high both in first instance courts and in appellate courts. The latter directly to the Court of Cassation.7 Easy access to the Court of Cassation has increased its inflow of cases from 3,000 per year in the 1960s to nearly 30,000 in recent years (Chiarloni, 1999). 100 Court Fees in Selected Jurisdictions 1/ (Thousands of euros) 100 75 75 50 50 25 25 0 0 35 30 25 NOR ITA GBR NLD DEU AUT Sources: Faure and Moerland (2006),; Ministry of Justice. 1/ High value commercial claims (> 3mn). For the UK data cover England and Wales only. The amounts are indicative since they vary according to the type of cases, thresholds and degrees of jurisdiction. 20 650 Number of Civil Cases Appealed (In thousands) Net inflow Stock of pending cases (right scale) 600 15 550 10 5 0 500 2008 2009 2010 della giustizia in Italia, Servizio Studi del Senato. 5 The share of court fees in supporting court expenditure ranked Italy in the bottom 6 countries of Council of Europe states in 2012 (OECD 2013:110, MoJ 2012). 6 Time needed to bring the case to an end. 7 The "Corte Suprema di Cassazione" or Court of Cassation is the highest court in the Italian judicial system. It the national law and the respect of the boundaries among the various national jurisdictions." INTERNATIONAL MONETARY FUND 27

ITALY 7. Also, the number of practicing lawyers in Italy is very high. This is considered one of the factors behind the high number of incoming cases 8 (Lupo, 2012). 450 450 Number of Lawyers (Per 100,000 inhabitants) 400 400 350 350 300 300 250 250 200 200 Greece Italy Spain Portugal Germany France 8. The workload of appeal courts is 150 150 steadily increasing with very limited scope to 100 100 reduce the inflow in the near future, despite 50 50 9 several legislative interventions. Law 83/2012 0 0 introduced new measures aimed, inter alia, at rationalizing the appeal system. In particular, the Source: CEPEJ. law provides that, with a number of exceptions,10 a if it does not have a reasonable chance of being accepted question, however, is how a court of appeal can determine, at first sight, whether an appeal has reasonable chances of being accepted, without actually re-litigating the case in full again or at least re-hearing the parties (even if in summary form) and thus determine whether it meets the test of inadmissibility. In addition, a dismissal may be appealed again before the Court of Cassation. 9. An important factor which boosts litigation is the relatively unpredictable outcome of court cases. Reports indicate that the high volume of cases at the Court of Cassation, in combination with frequent legislative changes, make it extremely hard for the Court of Cassation to deliver on its mandate of ensuring legal consistency. Also, the lengthy court process invites situations in which conflicting case law co-exists for a long time before an issue is finally settled before the Court of Cassation. This weakens respect for case-law, which in turn invites litigation and undermines confidence of both individual and businesses in the justice system as a whole (Muiznieks 2012). 10. Complex and lengthy court procedures contribute to delays in court proceedings and in the enforcement process.11 The regime is characterized, on the one hand, by rigidity, and, on the 8 9 The measures have shifted the burden to the appeal courts (Szego, 2008) where Italy has a high reversal rate (i.e. the rate at which appeal court overturn lower court decisions) (34.54 versus 11.74). A high reversal rate incentivizes appeals. The inflow of appeals cannot be solely tied to appeal grounds, but must be matched by improved quality of first instance courts. The proposed consolidation and specialization of the lower courts will help significantly in that respect. 10 See Article 348 bis of the Code of Civil Procedure. 11 The enforcement of courts decisions and other title documents in Italy is extremely complex and takes an exceedingly long time. Even the enforcement of a money claim, which as a fungible good should be simple, is a This particularly affects financial institutions which must go through long and expensive searches of public records to find out whether a debtor has assets for garnishment. There is no obligation for the debtor to provide full disclosure (continued) 28 INTERNATIONAL MONETARY FUND

ITALY Comparative Foreclosure Procedures in European Countries (2002) Global Compet. Index 2012 Mortgage loans in % of GDP Sweden 5.53 (4) NL 5.50 (5) Germany 5.48 (6) UK 5.45 (8) Denmark 5.29 (12) Austria 5.22 (16) France 5.11 (21) Spain 4.63 (36) Italy 4.46 (42) Source: Japelli et al. (2002) 56 43 27 52 -4 22 15 5 Down payment ratio Duration of mortgage foreclosure (months) 15 25 27 9 -30 20 20 42 -2-3 12-18 12 -13 10-12 36 36-60 Legal expenses as % of mortgaged house price -11 6 5 --12-18 5-15 18-20 other hand, by a great number of interim and interlocutory procedures. This allows for deferrals, and opens the door to a fragmentation of the actual dispute into a large number of sub-disputes, which are often subject to their own appeals. For example, the duration of foreclosure in Italy is amongst the highest in European countries, and with the highest costs. This increases overall transaction costs (a high down payment ratio, as well as interest rates), and the difficulty in accessing credit. The enforcement process itself (i.e. the execution of court decisions, orders or title documents) is highly problematic, with a low recovery rate and a lengthy time for collection (Chiarloni, 1999). Measures taken by the authorities 11. The Italian authorities have taken a number of measures to address the inefficiencies and bottlenecks in the functioning of their justice system. These include measures to reduce structure), promote out-of-court settlements (including by further enhancing mandatory mediation), reduce the number of courts (creating economies of scale and fostering specialization), strengthen court management (e.g., by giving a greater management role to the Chief Judge of a court, creating The steps have had some of their assets, and the access of bailiffs to public records, while expanded in 2005, is still restricted. The Code of Civil Procedure lacks a comprehensive regime of coercive orders, such as the French astreintes. The World Bank estimated the average length of a foreclosure procedure (attachment and auction of real estate) to take 90 months in Italy, which was seven times longer than similar procedures in most other European countries. See Silvestri (2010) for more details. INTERNATIONAL MONETARY FUND 29

ITALY positive effect, such as the 43 percent decline in the inflow of small claims as a result of increased fees. However, other measures described below have had mixed results. 12. The Pinto Law attempted to improve the situation in 2001 by giving litigants right to damages in case of excessively lengthy court proceedings. The Pinto Law (Law No. 89/2001), however, did not have the intended effect of speeding up the court process because it failed to build in the necessary incentives for the judiciary to reform.12 Instead, the law generated additional litigation and budgetary costs, and worsened the problems it meant to address,13 by creating more litigation instead of reducing it (Fabbri 2009, Bossi,, 2012).14 13. Funds used to compensate litigants for excessive delays in the judicial process could have been used to improve the efficiency of the justice system (Bossi, 2012). The compensation 15 awarded Instead of being used to compensate litigants for the excessive length of the judicial process, these funds could have been invested more usefully in supporting institutional changes. In response to Council of enacted legislation in 2012 which aimed at clarifying the scope of the Pinto Law, but it did not address the underlying incentive problems.16 14. The introduction of mandatory mediation in 2010 was another important corrective measure (Decree-Law 28/2010). While originally limited to specific disputes only, its scope was extended in 2011. The new system faced a number of challenges, both logistical and institutional. Despite the difficulties, reports indicate that the use of mediation increased following the enactment of the law,17 and was successful in siphoning off cases from the courts for at least some procedures (Severino 2012, Bank of Italy communication, June 29, 2013). This legislation was however declared unconstitutional by the Constitutional Court in October 2012 (see below for recent developments in the area of mediation). 12 Thus, even though the Pinto law specifically gave the Italian Court of Auditors to right to impose on judges the obligation to contribute to the damages, this right was hardly exercised, if ever. The compensation for Pinto Law cases did not, in fact, cut into the budget for the courts since a special allocation was granted. The Pinto Law therefore failed to create individual and institutional incentives for change (see Dipartimento affari giuridici e legali (Presidenza del Consiglio dei Ministri), Relazione al Parlamento anno 2010: - legge 9 Gennaio 2006, n.12 (2010).). 13 By 2011, about 50,000 Pinto Law cases were filed before the Italian Courts of Appeal, a fair number of which involved complaints of late payments of compensation awarded under Pinto Law actions. 14 Not coincidentally, as of 2011, approximately, 5,000 of the 14,500 pending applications against Italy before the arriving each month (Muiznieks 2012). 15 Presidency of the Council of Ministers, Misure per la crescita sostenibile (2012), p.13. 16 See Article 55 Decree-Law 83/2012 and conversion Law no.134 of August 7, 2012. (). 17 According to the International Institute for Conflict Prevention & Resolution, the number of mediation procedures increased from 1,000 to 250,000 over 2009 10. 30 INTERNATIONAL MONETARY FUND

ITALY 15. Further changes included streamlined first-instance court proceedings and online civil case management in pilot courts and civil procedure reforms were also adopted. These measures proved successful in some pilot courts, with the Torino and Bolzano courts often presented as success stories. Some of the measures were supported by EU structural funds.18 16. More recently, the soDecreto del Fare (Law 98/2013, August 2013) includes, inter alia, the following additional measures: Law-clerk apprenticeships to work in courts and support judges; A task force of 400 magistrates to clear the backlog in the courts of appeal; Compulsory mediation (see below); New associate judges in the Court of Cassation; Concentrating in the Naples, Milan, and Rome Courts all disputes involving foreign investors; and First hearing to be mandatory scheduled within 30 days and settlement of litigations expected at the first hearing in most cases. Key recommendations for further reforms 17. Reforms so far are steps in the right direction but shortcomings remain, impeding swift claim enforcement. To address these shortcomings, the judicial system should be further reformed to better support effective and efficient enforcement of civil and commercial claims. Consideration could be given to, inter alia, reviewing court fees, strengthening the new mandatory mediation scheme, improving court management and accountability, and reforming the appeal system. Reforms in these areas are key to reduce the overall number of incoming cases, while preserving access to justice, and to ensure a timely and effective resolution of the dispute when it enters the court system. (i) Public finance and litigation incentives court fees 18 Since 2004, the EU supported a roll(Program Title: Diffusion of best practices in the Italian Judicial Offices). This program made some progress (e.g. for the Milan Court). However, the program faced implementation constraints as well as jurisdictional issues between regional and central authorities. The central government has taken a stronger role in program management since 2010-2011, with the Ministry of Public Administration setting up an effective central monitoring system in 2011 and the Ministry of Justice putting in place professional management in 2012. This helped secure the EU structural funds. G. Vecchi International Journal for Court Administration February 2013), and INTERNATIONAL MONETARY FUND 31

ITALY 18. A comprehensive review of the economic incentives underlying the justice system is critical to the development of an effective and efficient judicial process. The objective should be to achieve a more reasonable and equitable distribution of the expenditure between the taxpayer and the market, while upholding basic principles of access to justice. A cost-redistribution is also likely to impact on the inflow of cases, by weeding out spurious and vexatious litigation. Recent cross-country developments in this area elsewhere in Europe could be useful guidance. 19. Court fees have generally increased throughout Europe (Faure, 2006; Hodges et al., 2010; CEPEJ, 2012). While no justice system is fully funded by court fees, a number of jurisdictions in Europe (e.g., the United Kingdom, the Netherlands, and Germany) have increased court fees significantly, notably for commercial procedures. Countries that did not have court fees, such as France, have now introduced them. Increasing or introducing court fees has three main beneficial effects: first, it helps prevent spurious litigation; second, it shifts the expenditure burden from taxpayers to litigants, and if carefully targeted, re-distributes the burden to those litigants most able to carry it; and third, it increases overall public revenue. 20. Recent measures adopted by the Italian authorities consolidate court fees to a certain 19

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